A Framework for Evaluating State-Assisted Financing Programs (1)

Abstract

State-assisted financing programs provide both economic and social benefits but can also affect state budgets and credit ratings. State-assisted financing programs are often touted as programs for mitigating or solving financial market imperfections, especially credit market failures. in reality, these programs are designed to: (1) address borrower credit risk problems; (2) provide a lender of last resort to small businesses during and immediately after economic recessions; (3) provide a less costly and more socially desirable alternative to direct social payments for people living in economically depressed regions or regions experiencing the strain of structural adjustment; and (4) direct funds into preferential uses. This paper provides an historical evolution of State-assisted financing programs in the United States and a framework for evaluating the financial costs associated with extending financial assistance to prospective recipients. Four categories of financing programs are reviewed: (1) concessionary finance for projects that already have positive private NPVs; (2) mitigating market imperfections financing for potentially positive private NPVs; (3) valuing social externalities subsidies for projects with negative private NPVs, but positive externalities producing a positive public NPV; and (4) politically compelling projects with negative private and public NPVs. A framework is developed that values loan guarantees as put options. Who pays the option premium and who receives the benefits depend on the fee charged for the guarantee and the interest rate the lender charges to the borrower whose loan has been guaranteed. Finally, the risks, moral hazards and policy issues of State-assisted financing programs are discussed and suggestions for overcoming special interest an d collective action obstacles are offered.